The US government is once again facing the very real possibility of shutting down on Wednesday, October 1st. That is, unless a last-minute agreement in Congress is reached that could avert the shutdown. However, with both Republicans and Democrats in an apparent impasse, that seems unlikely. What effect does this have on the markets?
Well, despite the concerning headlines, typically, markets shrug off a US government shutdown. Although rare, shutdowns have been increasing in frequency, and they usually end quickly without altering the market’s fundamentals. But there are some reasons to think this time could be a little different.
Why This Government Shutdown Could Affect Forex Markets
As mentioned, shutdowns typically have a minimal direct impact on the markets. In fact, on average, the US benchmark stock index has risen around 1% while the government was shut down. But two main factors can have an indirect effect on markets, and Forex more specifically: Timing and length.
All of the government’s essential functions continue to operate during a shutdown. The FAA, for example, continues to manage air traffic control to ensure no flight disruptions. Military operations continue, law enforcement and the justice system function as usual, etc. It’s ancillary things that are affected, such as access to federally-managed public parks. Specifically, relating to financial markets, the SEC continues to operate with a skeleton staff to monitor the markets. But, it doesn’t initiate new enforcement actions or review non-essential items, such as approving IPOs. In the short term, this has little impact on the markets. However, over time, the effects can accumulate, making traders increasingly nervous.
Why Some Traders are Concerned
One of the effects of a shutdown is that the government stops publishing its regular economic data releases, such as NFP, inflation, etc. These are key data points markets use to determine the state of the economy, so if they aren’t made available, it can lead to increased uncertainty in the market. However, as mentioned, prior shutdowns have usually been short, and if a major data release doesn’t fit into that window, then the issue has little impact on the market.
If the US government shuts down on October 1st, that could delay the publication of the NFP on Friday. With the Fed pointing to a deteriorating labor market as justification for rate cutting, leaving this data in suspense could make traders nervous. This is particularly relevant for the Forex market, because when risk appetite diminishes, investors often seek safe havens such as the US dollar, gold, and the yen.
What Could Happen In the Markets With a Government Shutdown?
If politicians in Washington fail to reach an agreement by the deadline, then the initial reaction in the markets is likely to be minimal. However, markets could become increasingly volatile, with funds shifting towards safe havens and defensive positions if the shutdown persists. The vast majority of shutdowns ended in less than a week. The most extended shutdown on record was 35 days. That resulted in a 0.4% decrease in US GDP growth during that quarter.
Currently, both political parties appear to believe they will benefit from a government shutdown. That could mean this time around it could last for a long time, depending on each party’s political calculus. If that happens, the markets could become increasingly risk-averse, which would support gold and the yen.
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